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DIVIDEND PAYOUT RATIO: AN INTERPRETATION





Q1. What is Dividend PayOut Ratio?

Answer: A company generally distributes a certain portion of its net income to its shareholders as a dividend. Such percentage of the dividend distribution out of the current earning is known as Dividend Payout Ratio. The remaining percentage of the earning is retained by the company as reserves and surplus. It is called retention ratio. Dividend payout ratio and retention ratio are like the two-wheel of a chariot. Both of them are part of the earning of the company. Their relationships can be better expressed by the following equation:


Dividend Payout Ratio + Retention Ratio = 1 or 100% (i.e. Total earning)


For Example, A company named XYZ Ltd has current year earning ( i.e. Net income) of $ 250,000. It distributes $50,000 in the form of dividends. The remaining $200,000 is retained as a reserve and surplus. Now the Dividend Payout Ratio is 0.2 and Retention ratio is 0.8. The sum of them both is equal to 1 (i.e total earning).


Q2. How is Dividend Payout Ratio calculated?

Answer: There are normally three different methods of calculation of Dividend Payout Ratio.

First Method:

Under this method, it is calculated dividing the amount of dividend paid to the shareholders by the Net income of the company during the current year.
Dividend Pay Out Ratio =                Total Dividends
                                                  Net Income For the same periods

Second Method:

Under the second method, it is calculated by with the help of the following equation:

Dividend Payout Ratio = ( 1 – Retention Ratio )

A company who has zero dividend payment ratio has retention ratio as 1. It means the company reinvests all of its earning for growth. Similarly, a company that has 100 % payout ratio has zero percent growth rate.


Third Method:

Under this method, the dividend payout ratio is calculated based on ‘ per share’ concept. Here it is calculated dividing the Dividend Per Share (DPS) by Earning Per Share (EPS).

Dividend Pay Out Ratio =              Dividend Per Share (DPS)
                                                         Earning Per Share (EPS)


Q3. The significance of Dividend Payout Ratio.

Answer: There are generally two types of investor. The first one is those who are willing to invest their funds in the companies that have the good growth potential and that has the good reinvestment plans and project. These type of investor are always focused towards the retention ratio.


The other one is those who are always interested to invest their fund in the profitable company that has the consistent dividend distribution track record. They always put their eye towards the Dividend Payout Ratio. Investors are mainly focused towards the consistent trend rather than high or low ratio.
Generally, those companies which are newer have low dividend payout ratio. On the other side, the mature and stable companies tend to increase their Dividend and therefore has high dividend payout ratio.  



Entity’s with higher earning and low Dividend payout ratio are generally that business who has the high growth potential. They are in their growth stage. Similarly, entity’s at their maturity and stable phase has higher dividend payout ratio and low growth potential. Such companies are planning for limited expansion.
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